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Ruling

Subject: Assessability of income from foreign life polices

Questions and answers:

1. From the time you became an Australian resident for taxation purposes until the relevant year, did the foreign investment fund measures in Part XI of the Income Tax Assessment Act 1936 operate to include the increase in value of your foreign life policies in your assessable income?

Yes.

2. Is any portion of the proceeds you received from the maturity of a foreign life insurance policy included in your assessable income?

Yes.

This ruling applies for the following period:

1 July 2007 to 30 June 2012.

The scheme commenced on:

1 July 2007.

Relevant facts and circumstances:

You became a resident of Australia for taxation purposes several years ago and have continued to be a resident of Australia for taxation purposes since that time.

You have held Australian citizenship since before becoming an Australian resident for taxation purposes.

In the decade prior to the subsequent financial year, you held three separate life insurance polices (the 1st, 2nd and 3rd policies) with an overseas life insurance company.

The 1st, 2nd and 3rd policies each had their own unique policy number, commencement date and maturity date.

You were the original beneficial owner of the 1st, 2nd and 3rd policies.

You were the insured person under the 1st, 2nd and 3rd policies.

The value of the 1st, 2nd, and 3rd policies increased annually until the maturity value of each policy was reached in the final year of each policy.

All three polices specified you would be paid the value of each policy at maturity should you survive to the relevant maturity dates.

The value of each policy always exceeded AUD $50,000.00.

The 1st policy matured before you became an Australian resident for taxation purposes.

You used the maturity value of the 1st policy to acquire the 2nd policy.

You used the maturity value of the 2nd policy to acquire the 3rd policy.

When the 3rd policy matured you received the maturity value of that policy. The amount you became received included a reversionary bonus.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-4

Income Tax Assessment Act 1997 Section 15-75

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 118-300

Income Tax Assessment Act 1936 Section 26AH

Income Tax Assessment Act 1936 Part XI (repealed)

Income Tax Assessment Act 1936 Section 485

Income Tax Assessment Act 1936 Section 487 (repealed)

Income Tax Assessment Act 1936 Section 515 (repealed)

Income Tax Assessment Act 1936 Section 517 (repealed)

Income Tax Assessment Act 1936 Section 529 (repealed)

Income Tax Assessment Act 1936 Section 536 (repealed)

Income Tax Assessment Act 1936 Subdivision E (repealed)

Income Tax Assessment Act 1936 Subdivision F (repealed)

Reasons for decision

Assessable income, resident taxpayers and foreign life policies - general

Sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provide that the assessable income of a resident taxpayer includes all the ordinary and statutory income they earn from all sources in or out of Australia in an income year.

Amounts of ordinary income are specifically included in a taxpayer's assessable income by the provisions of section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 specifies that an amount that is not ordinary income (and therefore not assessable under the provisions of section 6-5 of the ITAA 1997) will be assessable as an amount of statutory income if the amount is included in a taxpayer's assessable income by another provision of the tax law.

A list of the provisions that include specific amounts in a taxpayer's assessable income is contained in section 10-5 of the ITAA 1997. The list includes a number of provisions relevant to amounts received under a life insurance policy. These are:

· section 102-5 of the ITAA 1997, which includes in your assessable income any assessable gain made when a capital gains tax (CGT) event happens to a CGT asset that you own,

· the foreign investment fund (FIF) measures, which applied up to the end of the 30 June 2010 financial year to include certain amounts received under a foreign life policy (FLP) in a taxpayer's assessable income, and

· sections 15-75 of the ITAA 1997 and 26AH of the Income Tax Assessment Act 1936 (ITAA 1936), which apply (respectively) to the assessability of bonuses received under a life insurance policy, and to the assessability of bonuses and other amounts received under a short-term life assurance policy.

Capital gains tax

The CGT provisions are contained in Part 3-1 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own. In most cases the CGT asset must have been acquired on or after 20 September 1985 for the CGT provisions to apply to the asset.

A life insurance policy is a CGT asset for the purposes of the CGT provisions, however, section 118-300 of the ITAA 1997 allows you to disregard (and therefore exclude from your assessable income) any assessable gain or loss made from a policy of life insurance if you are the original beneficial owner of the policy.

When you became an Australian resident for taxation purposes the 2nd policy was in force and when that matured, the 3rd policy came into being. As both polices were acquired after 20 September 1985, both policies were CGT assets to which the CGT provisions in Part 3-1 of the ITAA 1997 applied. However, as you were the original beneficial owner of the 2nd and 3rd policies, you are entitled to disregard (and not include in your assessable income) any assessable gain or loss made from any CGT event that happened to either policy.

Application of the Foreign Investment Fund measures to amounts received under a Foreign Life Policy up to 30 June 2010

The FIF measures were contained in Part XI of the ITAA 1936 and applied up to 30 June 2010, prior to being repealed for income years ending 30 June 2011 and later. The FIF measures encompassed sections 469 to 624 inclusive of the ITAA 1936.

The following Australian Taxation Office (ATO) publications provide guidance on the application of the FIF measures to taxpayers with an interest in FLPs for the financial years ended 30 June 2008, 2009 and 2010:

· Taxation Ruling TR 2004/3W - Income tax: taxation of foreign life assurance (this ruling was withdrawn after the FIF measures were repealed but is still relevant for income tax years up to and including the year ended 30 June 2010).

· Foreign investment funds guide 2007-08.

· Foreign investment funds guide 2008-09.

· Foreign investment funds guide 2009-10.

Taxation Ruling TR 2004/3W specifies that:

· the FIF measures applied to any FLP with an investment component,

· a FLP that provides for a payment of money upon maturity is a policy with an investment component and is also a FLP as defined in section 482 of the ITAA 1936 for the purpose of the FIF measures,

· where a resident taxpayer holds an interest in a FLP that is a FLP as defined in section 482 of the ITAA 1936, the FIF measures operated to attribute income to the taxpayer each year the policy was held, and

· the practical effect of the FIF measures was that the increase in value of the amount held in the FLP would be included in the assessable income of the Australian resident on an annual basis.

A taxpayer is considered to have had an interest in a FLP if they had legal title to the policy.

The 1st, 2nd and 3rd policies all provided for a payment of money upon maturity. Therefore, each policy was a FLP with an investment component. As a FLP with an investment component, each policy was a FLP to which the FIF measures applied.

As the beneficial owner of the 1st, 2nd and 3rd policies, you had legal title to each of the polices. However, the FIF measures will only apply to your interests in FLPs from the period from when you became an Australian resident for tax purposes until 30 June 2010 (from which point the FIF measures were repealed and no longer applied to any taxpayer). Considering that the 1st policy matured before you became an Australian resident for taxation purposes, the FIF measures will only apply to the 2nd and 3rd policies.

The operative provision of the FIF measures that included the increase in value of a FLP in a taxpayer's assessable income was section 529 of the ITAA 1936.

Section 529 of the ITAA 1936 applied to subject a taxpayer to FIF taxation in a relevant income year if they:

· had an interest in a FLP at the end of a year of income, or at any time during a FLP's notional accounting period that ends in an income year, and

· the year of income was the 1992-93 or later year, and

· they were a resident of Australia for taxation purposes at any time in the relevant income year (subsections 485(3) and 485(4) of the ITAA 1936).

Regarding the application of section 529 of the ITAA 1936, TR 2004/3W notes that an amount of FIF income is not included in a taxpayer's assessable income if any of the exemption provisions available under the FIF measures applied.

An exemption from FIF taxation was available for taxpayers:

· with an interest in an FLP valued at AUD $50,000.00 or less, (section 515 of the ITAA 1936), or

· who were in Australia under a temporary visa issued under the Migration Act 1958 and who met certain other conditions in relation to their temporary residency status (section 517 of the ITAA 1936).

After becoming an Australian resident for taxation purposes you held an interest in either the 2^nd and/or 3^rd policies. Each policy was issued after the 1992-93 income year.

Given that your Australian citizenship predates you becoming an Australian resident for taxation purposes, the temporary resident exemption from FIF taxation cannot apply to you.

Furthermore, the value of the 2nd and 3rd policies always exceeded AUD $50,000.00.

Considering the above, and as neither of the exemptions is available to exempt you from FIF taxation on the increase in value of the 2^nd or 3^rd policies, the operative provision (section 529 of the ITAA 1936) applies to include an amount from those FLPs in your assessable income in the relevant financial years.

Determining the amount to be included in your assessable income under the FIF measures

Under the FIF measures, the amount to be included in the assessable income of a resident taxpayer with an interest in a FLP was based on a 'notional accounting period' of the relevant FLP.

Section 529 of the ITAA 1936 provided the following formula for determining the amount of FIF income to be included in your assessable income:

In this formula:

· FIF income is the amount of FIF income that accrued to you from the FLP in the notional accounting period.

· The number of days of residence is the number of days in the notional accounting period you were a resident.

· Total number of days means the number of days in the notional accounting period.

The notional accounting period of a FLP is generally each period of 12 months ending on 30 June (subsection 487(2) of the ITAA 1936). However, in cases where a cash surrender value of an interest in a FLP was available on a day during the same month in each calendar year (the relevant day), taxpayers could elect that the notional accounting period of the FLP be determined under subsection 487(5) of the ITAA 1936. For example, if the relevant day is in February, an election could be made for the notional accounting period to begin in March (the month commencing after the first relevant day) and ending at the end of February in the following year (when the next relevant day occurs). If made, such an election was irrevocable for as long as the interest in the FLP was held (subsection 487(4) of the ITAA 1936).

Two methods were available to determine the amount of FIF income to be used in the formula specified in section 529 of the ITAA 1936. These were:

· the deemed rate of return method (Subdivision E of the ITAA 1936, encompassing sections 584 to 594 of the ITAA 1936), and

· the cash surrender value method (Subdivision F of the ITAA 1936, encompassing sections 595 to 600 of the ITAA 1936).

The deemed rate of return method was applied unless a taxpayer elected to use the cash surrender method (subsections 536(1) and 536(2) of the ITAA 1936). An election to use the cash surrender method was irrevocable and could only be made if the taxpayer made an election (as discussed above) about the notional accounting period of the FLP under the provisions of section 487 of the ITAA 1936.

Your assessable income for the relevant financial years will include an amount of FIF income from the 2nd and 3rd policies. The amount to be included in your assessable income will be determined using the formula provided by Section 529 of the ITAA 1936. To apply the formula, you will need to determine the notional accounting period for the 2nd and 3rd policies, as well as whether you will use the deemed rate of return or the cash surrender method to determine the amount of FIF income to be included in the calculation.

Assessability of life insurance policy bonus - sections 6-5 and 15-75 of the ITAA 1997, and 26AH of the ITAA 1936

Bonuses received under a policy of life insurance are not income according to ordinary concepts and are therefore not assessable under the provisions of section 6-5 of the ITAA 1997.

However, and as stated previously, insurance bonuses are potentially assessable to a taxpayer under the provisions of section 15-75 of the ITAA 1997, or section 26AH of the ITAA 1936.

Section 15-75 of the ITAA 1997 provides that:

· your assessable income includes any amount you receive as or by way of a bonus on a life insurance policy, other than a reversionary bonus, and

· a reversionary bonus may be assessable under the provisions of section 26AH of the ITAA 1936.

A bonus received under a life insurance policy is a reversionary bonus when the entitlement to the bonus only accrues upon maturity of the policy and is not payable annually.

Although a bonus may be credited to a FLP on an annual basis, that is not to say the bonus is one that is 'payable annually', as opposed to a bonus to which the 'entitlement' accrues at maturity (and is therefore a reversionary bonus). Paragraph 7 of Taxation Ruling No. IT 2346 - income tax: bonuses paid on certain life assurance policies - section 26AH - interpretation and operation deals with the meaning of the word 'received' in the context of section 26AH of the ITAA 1936 and states:

Section 26AH primarily applies to amounts actually received by a taxpayer as or by way of a bonus under an eligible policy. However, sub-section 26AH(4) operates, subject to sub-section 26AH(5), to ensure that where an amount of bonus is dealt with on behalf of or at the direction of the taxpayer, he or she is taken to have received that amount. It is important to note, however, that the mere crediting of a bonus to a policy of life assurance is not to be taken as the receipt by the taxpayer of the bonus. In this regard, sub-section 26AH(5) provides that sub-section 26AH(4) does not apply to a bonus or similar amount that is applied to increase the surrender or maturity value of a life assurance policy.

In simple terms, paragraph 7 of Taxation Ruling No. IT 2346 means that although a bonus may be credited annually to a FLP by way of an increase in value of the FLP, the taxpayer is not taken to have received that bonus until the FLP matures and the taxpayer becomes entitled to the maturity value. When this happens and the taxpayer chooses to use the maturity value (including any bonus earned on the FLP) of a FLP to acquire another FLP, the taxpayer is taken to have actually received the bonus under the provisions of sub-section 26AH(4) of the ITAA 1936 because the bonus is considered to have been dealt with either on behalf of, or at the direction of the taxpayer. The exemption provided in sub-section 26AH(5) of the ITAA 1936 does not apply in situations such as this because it cannot be said that the bonus included in the maturity value of the FLP was applied to increase the surrender or maturity value of a FLP. Rather, the bonus has been applied to acquire a new FLP.

Applying this to your circumstances, we can see that:

· The annual increases in value of the 2nd and 3rd policies represented reversionary bonuses. This is the case because the increases in value were not payable to you on an annual basis. Rather, you became entitled to the value of the increases on the maturity date of each policy.

· You are taken to have received a reversionary bonus from the 3rd policy when you became entitled to the funds from that policy on maturity.

· The reversionary bonus you are taken to have received in respect of the 3rd policy is the difference between the acquisition cost and the maturity value of the 3rd policy.

· In relation to the 2nd policy, you are taken to have received a reversionary bonus from that policy when you used the maturity value of the 2nd policy to acquire the 3rd policy. By using the maturity value of the 2nd policy in this fashion, the maturity value is considered to have been dealt with either on your behalf or at your direction.

· The reversionary bonus you are taken to have received in respect of the 2nd policy is the difference between the acquisition cost and the maturity value of the 2nd policy.

· The exemption in subsection 26AH(5) of the ITAA 1936 does not apply to the reversionary bonus you are taken to have received from the 2nd policy. This is the case because although you did not physically receive the funds from the maturity of the 2nd policy, those funds (including the increase in value of the policy) were used to acquire a new FLP, rather than being applied to increase the surrender or maturity value of an existing FLP.

Neither of the reversionary bonuses you are taken to have received in respect if the 2nd or 3rd policies are assessable as ordinary income under the provisions of section 6-5 of the ITAA 1997, or as statutory income under section 15-75 of the ITAA 1997. However, the amounts are assessable to you as statutory income under the provisions of section 26AH of the ITAA 1936 as discussed below.

Section 26AH of the ITAA 1936 - Bonuses and other amounts received in respect of certain short term life assurance policies

Section 26AH of the ITAA 1936 provides that a taxpayer's assessable income shall include bonuses, and some other amounts in the nature of bonuses, received under an eligible policy during the eligible period.

A FLP with a date of commencement of risk after 27 August 1982 is an eligible policy.

The date of commencement of risk is the date of commencement of the period to which the first or only premium paid under the policy relates, or where the first or only premium does not relate to a particular period, the date of payment of that premium.

For eligible policies with a date of commencement of risk after 7 December 1983, the eligible period is the first 10 years of the policy.

Subsections 26AH(6) and (14) of the ITAA 1936 provide that a reversionary bonus received in respect of an eligible policy with a date of commencement of risk after 7 December 1983 is assessable as follows:

· If the reversionary bonus is received within the first eight years of the eligible period, the amount is assessable in full.

· If the reversionary bonus is received during the ninth year of the eligible period, two thirds of the reversionary bonus is assessable.

· If the reversionary bonus is received during the tenth year of the eligible period, one third of the reversionary bonus is assessable.

Under the provisions of subsection 26AH(2) of the ITAA 1936, a reversionary bonus is potentially not assessable under section 26AH of the ITAA 1936 if a paid up policy is issued to a taxpayer in lieu of an eligible policy. Where this is the case no amount is taken (for the purposes of subsection 26AH(4) of the ITAA 1936) to have been reinvested or otherwise dealt with on behalf of the taxpayer or as he or she directs. In other words, a taxpayer in this situation is not taken to have received an amount event if the amount is reinvested or otherwise dealt with on behalf of the taxpayer to result in the issuing of a paid up policy.

The provisions of subsection 26AH(2) of the ITAA 1936 do not apply when an eligible policy is created in circumstances where the maturity value of one eligible policy is used to acquire a new life assurance policy that is considered an eligible policy. In support of this position, paragraph 14 of IT 2346 states:

… where existing eligible policies are consolidated by applying cash surrender values and accumulations in respect of those policies into a new life assurance policy, … a new eligible policy is created.

Paragraph 14 of IT 2346 goes on to state that:

… by virtue of sub-section 26AH(4), the value to be attached to an existing eligible policy on termination shall be taken to have been received by the taxpayer even though the amount may not be paid to the taxpayer but is reinvested on the taxpayer's behalf to obtain a new life assurance policy.

The view expressed in paragraph 14 of IT 2346 (that a new eligible policy is created when cash surrender values and accumulations from an existing eligible policy are consolidated into a new policy) has clear application to your circumstances. This is especially the case when we consider that the 1st, 2nd and 3rd policies each had their own unique policy number, commencement date and maturity date. In these circumstances, there can be no doubt that each of your FLPs were separate policies in their own right, rather than a continuation of any previous policy.

Considering the above, the 2nd and 3rd policies are both eligible policies for the purpose of section 23AH of the ITAA 1936 because the date of commencement of risk for each policy is after 27 August 1982.

The eligible period for the 2nd and 3rd policies is the first 10 years of each policy (notwithstanding the fact that neither policy existed for that period of time) because the date of commencement of risk for both is after 7 December 1983.

The reversionary bonuses you are taken to have received from the 2nd and 3rd policies are assessable in full in the year you are taken to have received them under the provisions of paragraph 26AH(6)(a) of the ITAA 1936 because each amount was received within eight years of the eligible period for each policy.

Prevention of double taxation on payments received from FLPs

Section 23AK of the ITAA 1936 provides a mechanism whereby taxpayers are protected against double taxation of amounts assessable to them in respect of FLPs under the FIF measures.

Under the provisions of section 23AK of the ITAA 1936, when a taxpayer with an interest in a FLP receives a payment from the life company in relation to the policy, the amount of the payment is treated as non-assessable non-exempt income to the extent of previously attributed income. For example, where a taxpayer receives a payment relating to a FLP by way of a reversionary bonus that would otherwise be assessable under section 26AH, such amount would be treated as non-assessable non-exempt income to the extent that the taxpayer has already been subject to tax under the FIF attribution rules.

Conclusion

Your assessable income for the relevant financial years will include an amount of FIF income from the 2nd and 3rd policies. The amount to be included in your assessable income will be determined using the formula provided by Section 529 of the ITAA 1936. To apply the formula, you will need to determine the notional accounting period for the 2nd and 3rd policies, as well as the whether you will use the deemed rate of return or the cash surrender method to determine the amount of FIF income to be included in the calculation.

The reversionary bonuses you are taken to have received from the 2nd and 3rd policies are also included in your assessable income under the provisions of section 23AH of the ITAA 1936, but only to the extent that you have not already been subject to taxation under the FIF measures on the increase in value of your FLPs.